It looks to be a rocky start to the new week in the world financial markets. Major stock indexes in Europe plunged between 2.42% and 4.57% in trading there. What is the big driver of this new sell off? The renewed fear of a Greek debt default and all that would mean for European banks that have large amounts of Greek bonds on their balance sheets.
The slowly dawning realization that no amount of austerity is going to allow the Greek government to cover its financial commitments and a growing reluctance by the German government to even try is putting a fairly panicked patina on the world markets.
It is not like this is really that unexpected. The problem is that as the Greek government has slashed spending and wages and hours, their economy has slowed down. The unemployment rate in Greece has is nearly 16% and that only counts those who are looking for work, not so-called discouraged workers.
With that level of unemployment any cuts in demand just wind up as more unemployed workers who can’t afford to spend very much. This means there is less tax collected, less production needed and more people are likely to be laid off.
The next logical step for Greece is to default on its debt. This could be good for Greece in the long run, but in the short run it is likely to make the Euro Zone a really unhappy place. The index that lost the most value today was the French CAC. This is because Frances three largest banks are major holders of Greek debt. All three are expected to be down graded by credit rating agencies some time this week for this very reason.
If this seems familiar it is because it is very similar to the way that our own housing bubble collapse played out. Risky debt began to become a liability and the amount of it in the hands of US and other nations banks threatened to rob them of the liquidity they needed and make it nearly impossible for them to borrow money short term.
That it is happening to the second strongest economy in the Euro Zone is making a lot of investors nervous, and with good reason. The Washington Post quoted the German Finance Minister as saying:
“To stabilize the euro, we must not take anything off the table in the short run,” Roesler told Germany’s Die Welt newspaper. “That includes as a worst-case scenario an orderly default for Greece if the necessary instruments for it are available.”